Markets

Charge! Credit Card Companies Outlasting Economic Storm

Despite swelling delinquencies and reform pressure from the government, credit card companies are using pricing power and staying power to beat the heat.

AP

Little of the news has been good lately for companies like MasterCard and Visa, with Fitch Ratings adding more misery to the sector Wednesday by reporting that delinquencies are at a record high.

At the same time, new government regulations are limiting when issuers can change rates and providing new protections for consumers that are likely to be burdensome on the companies.

Yet even Fitch said issuers are likely to be "resilient" in the face of the industry's challenges, and an analyst report earlier this week added strength to the notion that credit card companies are a strength group on the investment horizon.

"They're OK from a capital standpoint to kind of ride through the cycle," said Sanjay Sakhrani, an analyst at Keefe, Bruyette and Woods, which released a generally upbeat assessment Monday of the major credit card companies. "Past that, I think that they may have the potential to take some share in a less competitive environment."

Sakhrani said the pressures of default writedowns combined with a more restrictive regulatory picture would reduce profitability in the industry but actually help some of the larger firms that have more reserve capital and greater pricing flexibility.

Moreover, he said the scarcity of home equity loans as real estate prices have fallen have consumers turning more to their credit cards for financial help.

Indeed, Fitch said pricing moves that have pushed up gross yields for issuers have created a "stable" environment for investors in the asset-backed securities market in credit cards.

Credit card losses hit a record 10.44 percent in June, pushing profit margins to levels not seen since November 1998, Fitch said. The rate is 62 percent higher than the same period last year.

Excess spread, a key measure of profitability in the space, is at 4.83 percent, down from May's 5.30 percent. But ratings on asset-backed securities remain stable as companies "have added more credit enhancement and turned on the discount option in order to deal with the sour economy," Fitch said in a statement.

"There's still going to be significant negatives facing the group as far as headline risk," said Justin Wiggs, vice president of trading at Baltimore-based Stifel Nicolaus. "The space has kind of bottomed out as far as people becoming a little less pessimistic. With a lot of negatives built into the space, even slight changes of how negative things might have ended up being can change earnings significantly going forward. ... The top six companies are going to make money."

While warning of its volatility, Wiggs said Capital One should be among the best performers.

In its analysis, KBW raised Discover Financial Services to "outperform" from "market perform."

The company kept its outperform rating on both Visa and MasterCard , while saying it is "increasingly getting more constructive" on American Express . KBW kept its market perform rating on Capital One, saying "the company must work through the impacts of the new card law."

To be sure, not everyone is so sanguine on the group's potential.

Zacks Equity Research said the surge in delinquencies indicates "very bad news for the big players," a group in which it includes American Express, Capital One, Bank of America and JPMorgan Chase .

And with unemployment expected to continue higher — most economists see the rate nudging 11 percent before a turnaround — consumer weakness could be a major obstacle for credit cards.

"I don't want exposure to the US consumer," said Lee Markowitz, partner at Continental Capital Advisors in New York. Speaking of recent easing in some economic pressures but a drop in consumer confidence, Markowitz said, "This is like the eye of the storm. ... This consumer confidence (drop) is the start of another leg down."

But supporters of investing in credit card companies say the inevitable consumer rebound plus smart management practices make the space a sound investment.

"The industry will adjust and people will still find utility in having credit cards for a number of reasons," Sakhrani said. "You get a float for every month to pay your balance, you get fraud protection, you get rewards, security, you don't have to walk around with cash. All those are reasons to have a credit card still."